Thursday, May 7, 2015

Recently, there has been
a great deal of discussion about China's slowing economy with projections that
growth could "slow" to the 7 percent range. While this is of
concern, largely because the global economy has depended on China's phenomenal
economic growth rates to prop up the weaker economies of the developed nations,
a paper, "Asiaphoria Meet Regression to the
Mean", by Lawrence Summers and Lant Pritchett shows that even these
projections may be excessively optimistic over the long-term.

Over the decade and a
half, China's growth rate peaked at 13 percent in Q1 2007 and hit a low of 6.2
percent in Q1 2009 during the depths of the Great Recession. Keeping in
mind that the rest of the developed world was experiencing an economic
contraction during this period, China's growth during the global crisis was
positively stellar.

According to the World
Bank's Global Economic Prospects for 2015, China's
growth is forecast to be 7.1 percent in 2015, 7.0 percent in 2016 and 6.9
percent in 2017, compared to an average of 2.2, 2.4 and 2.2 percent
respectively for the world's developed economies as shown on this table:

You will note that, even
though China's growth rate is projected to slow, by 2017 it is still the second
highest among all developing economies after Bangladesh and India.

Now, let's go back to the
paper by Summers and Pritchett. The authors open their paper by noting
that there are two common failures in economic forecasting:

1.) excessive
extrapolation of the (recent) past into the (distant) future with particular
susceptibility to irrational exuberance.

The authors note that
this is particularly the case in growth projections for China and India;
despite the recent somewhat less bullish forecasts, the forecasts of future
global economic growth still hinge on growth that is super-rapid in both China
and India.

The rise of Asia's
economic miracle has taken place in three stages:

1.) the rise of
post-World War II Japan.

2.) the rise of the East
Asian Dragons, including Korea, Taiwan, Hong Kong and Singapore.

3.) the rise of China and
India.

This has produced what
the authors term "Asiaphoria".

The rise of the economic
power of China and India has occurred over a period of decades, largely because
of their growing populations. Most economists now regard these two
nations as the drivers of the world's economy and that the global centre of
gravity will continue shifting to Asia as Vietnam, Indonesia and Thailand join
the party. With lukewarm growth rates in the world's developed economies,
most economists feel that China and India will continue, long into the future,
to be the lynchpins of the global economy.

Summers and Pritchett
note that, predicting future economic growth by extrapolating past and current growth
rates into the future is a dangerous game, largely because, history shows that
economies tend to grow at more modest rates over time, in other words, economic
growth rates regress to the mean. In other words, extreme levels of
economic growth have no lasting power over the long-term. While it could
be possible that China's economy continues to grow for another two decades at a
9 percent annual rate, given the regression to the mean, this would be a 3
standard deviation anomaly.

The author's calculations
show that there has been a low persistence of growth rates across all ten year
periods from 1950 to 2010 with the data showing that there is a strong
regression to the mean level of economic growth across an entire decade.
As well, there is less persistence in the growth rates from 1990 to 2000
and 2000 to 2010 than in the previous decades. This tells us that using
current growth rates to predict what the economy will look like two
decades ahead will lead to severely inaccurate projections. As the authors so
eloquently put it, "In general, past growth is just not that informative
about future growth.".

Here is a table showing
the author's calculations of what will happen to the economies of China and
India over ten and twenty year horizons using growth rates that are similar to
the levels of 2000 to 2010 and a growth rate of 2 percent (full regression to
the mean):

As you can see, the end
GDP result is significantly different if the growth rates of both China and
India revert to the mean. Let's focus on China since their economy is
currently far more significant to the world's economy. If China's economy
continues to grow at its current rate out to 2033, the nation's GDP will hit
$60.034 trillion or more than three times the size of the current U.S. economy
($17.07 trillion). If, however, GDP
growth rates fall to the mean of 2.0 percent, Chinas GDP in 2033 will be
$20.077 trillion or one-third of what it would have been had the current growth
rate continued for another two decades.

This huge difference in growth of
just under $40 trillion will have a substantial impact on the global economy.
Here is a table that shows the impact of changes to the growth rates of
China and India to the world's economy:

If we assume that the
rest of the world grows at a steady 2.2 percent, hitting $93 trillion in 2033
and China and India continue at their current growth rates, in 2033, their
current GDP will be $66.8 trillion which will result in a global annual
economic growth rate of 4.45 percent, largely because of the high level of
growth in China and India. If, however, China and India see their growth
rates revert to the mean (i.e. 2 percent), the global growth rate will fall to
just over half of the aforementioned rate, dropping to 2.27 percent.

To summarize, Summers and
Pritchett note that the typical (or median) end to an episode of super-rapid
economic growth is nearly complete regression to the mean with that growth rate
being around 2.1 percent per year. As shown on this table, the average
deceleration of economic growth among all nations with growth rates that
exceeded 6 percent annually is 4.65 percentage points:

In the case of China, its
8.63 percent long-term average growth rate is most likely to decline to 3.98 percent, a
factor that will have a significant negative impact on the world's economy
since China is a huge consumer of many of the primary products produced by the
developed world.

1 comment:

This "article" is a joke. It keeps lumping indian in with China in economic growth and development and NOTHING COULD BE FARTHER FROM THE TRUTH.

In the last decade, China has simply straightforwardly galloped away from India. Since 2010, the "booming indian economy" has consisted of <5 to 6% economic growth: hardly "east asian miracle" numbers.

As a result China went from having an economy that was a little over double the size of the Indian economy in 2002 to where today China's GDP is nearly 6 TIMES that of the Indian GDP.

The economic growth of India may be impressive compared to the "old" "mature" economies of Canada/United States/Europe/Japan/Australia/etc. but it in NO WAY can compare to the "EAST Asian Economic Miracles" of the 1970s/80s/90s/00s/10s.

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About Me

I have been an avid follower of the world's political and economic scene since the great gold rush of 1979 - 1980 when it seemed that the world's economic system was on the verge of collapse. I am most concerned about the mounting level of government debt and the lack of political will to solve the problem. Actions need to be taken sooner rather than later when demographic issues will make solutions far more difficult. As a geoscientist, I am also concerned about the world's energy future; as we reach peak cheap oil, we need to find viable long-term solutions to what will ultimately become a supply-demand imbalance.